Trade Credit, Financial Intermediary Development and Industry Growth

Recent work suggests that financial development is important for economic growth, since financial markets more effectively allocate capital to firms with high value projects. For firms in poorly developed financial markets, implicit borrowing in the form of trade credit may provide an alternative source of funds.We show that industries with higher dependence on trade credit financing exhibit higher rates of growth in countries withweaker financial institutions. Furthermore, consistent with barriers to trade credit access among young firms, we show thatmost of the effect that we report comes from growth in the size of preexisting firms. IN RECENT YEARS, there has been increasing interest in the economics literature in the role of financial intermediaries in promoting economic growth. Recent papers have shown that improved financial market development is associated with growth, using avariety of methodologies and data sets.One of the basic explanations for this pattern is that the financial sector serves to reallocate funds from those with an excess of capital, given their investment opportunities, to those with a shortage of funds (relative to opportunities).Thus, an economy with welldeveloped financial institutions will be better able to allocate resources to projects that yield the highest returns. This allocative role of financial institutions in promoting development was the focus of Rajan and Zingales (1998), who found that industrial sectors with a greater need for external finance develop disproportionately faster in countries with more developed financial markets.This then begs the question of whether firms with high return projects in countries with poorly developed financial instituTHE JOURNAL OF FINANCE VOL. LVIII, NO. 1 FEB. 2003 Fisman is at the Graduate School of Business, Columbia University, and Love is at the World Bank.We thank Charles Calomiris, Stijn Claessens, and an anonymous referee for helpful comments, and Raghuram Rajan and Luigi Zingales for kindly allowing us to use their data in this paper. Perhaps the earliest work relating financial market development to economic growth is Cameron (1967). More recent work that examines this relationship using cross-country data includes King and Levine (1993) and Demirguc-Kunt and Maksimovic (1996). More sophisticated approaches have been utilized by Rajan and Zingales (1998), who use within-country variation in industry characteristics; Bekaert, Harvey, and Lundblad (2000), who make use of time-series variation in looking at the effect of financial liberalization on growth; and Rousseau and Wachtel (1998), who look at the links between the intensity of financial intermediation and economic performance in five industrialized countries.